ECON 214 HW20 Aggregate Demand and Supply Assignment solutions complete answers

ECON 214 HW20 Aggregate Demand and Supply Assignment solutions complete answers

 

1. Key facts about economic fluctuations

The graph included below approximates United States business cycles between quarter one of 1953 and quarter three of 1957. The shaded region denotes periods of six or more consecutive months of declining real gross domestic product (real GDP).

 

Notice that real GDP trends upward over time but experiences ups and downs in the short run. A period of declining real GDP, such as the blue-shaded period in 1953, is known as    .

True or False: Short-term fluctuations in real GDP are irregular and unpredictable.

 True

 False

Which of the following probably occurred as the U.S. economy experienced increasing real GDP in 1954?  Check all that apply.

 Home sales declined.

 The unemployment rate declined.

 Consumer spending increased.

 Retail sales increased.

 

The graph included below approximates United States business cycles between quarter one of 1947 and quarter three of 1951. The shaded region denotes periods of six or more consecutive months of declining real gross domestic product (real GDP).

 

Notice that real GDP trends upward over time but experiences ups and downs in the short run. These short-run fluctuations in real GDP are often referred to as    .

True or False: Small ups and downs in real GDP follow a consistent, predictable pattern.

 True

 False

Which of the following probably occurred as the U.S. economy experienced declining real GDP in 1948?  Check all that apply.

 Car sales increased.

 The unemployment rate increased.

 Consumer spending increased.

 Corporate profits declined.

 

The graph included below approximates United States business cycles between quarter one of 1955 and quarter three of 1959. The shaded region denotes periods of six or more consecutive months of declining real gross domestic product (real GDP).

 

Notice that real GDP trends upward over time but experiences ups and downs in the short run. A period of declining real GDP, such as the blue-shaded period in 1957, is known as    .

True or False: Small ups and downs in real GDP follow a consistent, predictable pattern.

 True

 False

Which of the following probably occurred as the U.S. economy experienced declining real GDP in 1957?  Check all that apply.

 Retail sales declined.

 Industrial production increased.

 Home sales increased.

 Consumer spending declined.

 

2. Explaining short-run economic fluctuations

A majority of economists believe that in the long run, real economic variables and nominal economic variables behave independently of one another.

For example, an increase in the money supply, a    variable, will cause the price level, a    variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a    variable. The distinction between real variables and nominal variables is known as     .

However, in the short run, most economists believe that real and nominal variables are intertwined. Economists use the model of aggregate demand and aggregate supply to examine the economy's short-run fluctuations around the long-run output level. The following graph shows an incomplete short-run aggregate demand (AD) and aggregate supply (AS) diagram—it needs appropriate labels for the axes and curves. In the questions that follow you will identify some of the missing labels.

 

The aggregate    curve shows the quantity of output that households, firms, the government, and foreign customers want to buy at each price level.

The vertical axis of the aggregate demand and aggregate supply model measures the overall    .

 

A majority of economists believe that in the long run, real economic variables and nominal economic variables behave independently of one another.

For example, an increase in the money supply, a    variable, will cause the price level, a    variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a    variable. The notion that an increase in the quantity of money will impact the price level but not the output level is known as    .

However, in the short run, most economists believe that real and nominal variables are intertwined. Economists use the model of aggregate demand and aggregate supply to examine the economy's short-run fluctuations around the long-run output level. The following graph shows an incomplete short-run aggregate demand (AD) and aggregate supply (AS) diagram—it needs appropriate labels for the axes and curves. In the questions that follow you will identify some of the missing labels.

 

The aggregate    curve shows the quantity of output that households, firms, the government, and foreign customers want to buy at each price level.

The horizontal axis of the aggregate demand and aggregate supply model measures the overall    .

 

A majority of economists believe that in the long run, real economic variables and nominal economic variables behave independently of one another.

For example, an increase in the money supply, a    variable, will cause the price level, a    variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a    variable. The notion that an increase in the quantity of money will impact the price level but not the output level is known as    .

However, in the short run, most economists believe that real and nominal variables are intertwined. Economists use the model of aggregate demand and aggregate supply to examine the economy's short-run fluctuations around the long-run output level. The following graph shows an incomplete short-run aggregate demand (AD) and aggregate supply (AS) diagram—it needs appropriate labels for the axes and curves. In the questions that follow you will identify some of the missing labels.

 

The aggregate    curve shows the quantity of goods and services that firms produce and sell at each price level.

The horizontal axis of the aggregate demand and aggregate supply model measures the overall    .

 

3. Why the aggregate demand curve slopes downward

The graph below shows the aggregate demand (AD) curve for a hypothetical economy. At point X, the quantity of output demanded is $300 billion, and the price level is 140. Moving down along the AD curve from point X to point Y, the quantity of output demanded rises to $500 billion, and the price level falls to 120.

 

As the price level falls, the cost of borrowing money will    , causing the quantity of output demanded to    . This phenomenon is known as the    effect.

Additionally, as the price level falls, the impact on the domestic interest rate will cause the real value of the dollar to    in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore    , and the number of foreign products purchased by domestic consumers and firms (imports) will    . Net exports will therefore    , causing the quantity of domestic output demanded to    . This phenomenon is known as the    effect.

 

The graph below shows the aggregate demand (AD) curve for a hypothetical economy. At point X, the quantity of output demanded is $500 billion, and the price level is 120. Moving up along the AD curve from point X to point Y, the quantity of output demanded falls to $300 billion, and the price level rises to 140.

 

As the price level rises, the purchasing power of households' real wealth will    , causing the quantity of output demanded to    . This phenomenon is known as the    effect.

Additionally, as the price level rises, the impact on the domestic interest rate will cause the real value of the dollar to    in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore    , and the number of foreign products purchased by domestic consumers and firms (imports) will    . Net exports will therefore    , causing the quantity of domestic output demanded to    . This phenomenon is known as the    effect.

 

The graph below shows the aggregate demand (AD) curve for a hypothetical economy. At point X, the quantity of output demanded is $500 billion, and the price level is 120. Moving up along the AD curve from point X to point Y, the quantity of output demanded falls to $300 billion, and the price level rises to 140.

 

As the price level rises, the purchasing power of households' real wealth will    , causing the quantity of output demanded to    . This phenomenon is known as the    effect.

Additionally, as the price level rises, the impact on the domestic interest rate will cause the real value of the dollar to    in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore    , and the number of foreign products purchased by domestic consumers and firms (imports) will    . Net exports will therefore    , causing the quantity of domestic output demanded to    . This phenomenon is known as the    effect.

 

4. Determinants of aggregate demand

The graph below is associated with a hypothetical country. Consider an increase in aggregate demand (AD). Specifically, aggregate demand shifts to the right from AD1AD1 to AD2AD2, causing the quantity of output demanded to rise at each price level. For instance, at a price level of 140, output is now $400 billion, where initially it was $300 billion.

 

The following table lists several determinants of aggregate demand.

Fill in the missing values in the table by selecting the change in each scenario required to increase aggregate demand.

 
Change Required to Increase AD
Expected rate of return on investment
    
Incomes in other countries
    
Consumer expectations about future profitability
    
Government spending
    
 

The graph below is associated with a hypothetical country. Consider a decrease in aggregate demand (AD). Specifically, aggregate demand shifts to the left from AD1AD1 to AD2AD2, causing the quantity of output demanded to fall at each price level. For instance, at a price level of 140, output is now $200 billion, where initially it was $300 billion.

The following table lists several determinants of aggregate demand.

Fill in the missing values in the table by selecting the change in each scenario required to decrease aggregate demand.

 
Change Required to Decrease AD
Interest rates
    
Domestic currency value relative to the foreign currency
    
Wealth
    
Taxes
    
 

The graph below is associated with a hypothetical country. Consider a decrease in aggregate demand (AD). Specifically, aggregate demand shifts to the left from AD1AD1 to AD2AD2, causing the quantity of output demanded to fall at each price level. For instance, at a price level of 140, output is now $200 billion, where initially it was $300 billion.

The following table lists several determinants of aggregate demand.

Fill in the missing values in the table by selecting the change in each scenario required to decrease aggregate demand.

 
Change Required to Decrease AD
Expected rate of return on investment
    
Incomes in other countries
    
Consumer expectations about future profitability
    
Government spending
    
 

5. The slope and position of the long-run aggregate supply curve

Assume the Federal Reserve triples the growth rate of the quantity of money in circulation. In the long run, this increase in money growth will affect which of the following? Check all that apply.

 The size of the labor force

 The inflation rate

 The price level

 The level of technological knowledge

Suppose when unemployment is at its natural rate the economy produces a level of real GDP equal to $60 billion.

Using the purple points (diamond symbol) plot the economy's long-run aggregate supply (LRAS) curve on the graph.

 

Suppose now the government passes a law that significantly increases the minimum wage. This change in policy will cause the natural rate of unemployment to    , which will:

 Shift the long-run aggregate supply curve to the right

 Shift the long-run aggregate supply curve to the left

 Not impact the long-run aggregate supply curve

Complete the following table by determining how each event impacts the position of the long-run aggregate supply (LRAS) curve.

 
Direction of LRAS Curve Shift
An investment tax credit increases the rate at which firms acquire machinery and equipment.
    
The government allows more immigration of working-age adults who find work.
    
For environmental and safety reasons, the government requires that the country's nuclear power plants be permanently shut down.



 

Assume the Federal Reserve triples the growth rate of the quantity of money in circulation. In the long run, this increase in money growth will affect which of the following? Check all that apply.

 The level of technological knowledge

 The size of the labor force

 The inflation rate

 The price level

Suppose when unemployment is at its natural rate the economy produces a level of real GDP equal to $40 billion.

Using the purple points (diamond symbol) plot the economy's long-run aggregate supply (LRAS) curve on the graph.

 

Suppose now the government passes a law that reduces unemployment benefits in a way that causes unemployed workers to seek out new jobs more quickly. This change in policy will cause the natural rate of unemployment to    , which will:

 Not impact the long-run aggregate supply curve

 Shift the long-run aggregate supply curve to the left

 Shift the long-run aggregate supply curve to the right

Complete the following table by determining how each event impacts the position of the long-run aggregate supply (LRAS) curve.

 
Direction of LRAS Curve Shift
A natural disaster destroys a significant amount of the economy's production facilities.
    
Many workers leave to pursue more lucrative careers in foreign economies.
    
A scientific breakthrough significantly increases food production per acre of farmland.
    
 

Assume the Federal Reserve triples the growth rate of the quantity of money in circulation. In the long run, this increase in money growth will affect which of the following? Check all that apply.

 The price level

 The size of the labor force

 The level of technological knowledge

 The inflation rate

Suppose when unemployment is at its natural rate the economy produces a level of real GDP equal to $30 billion.

Using the purple points (diamond symbol) plot the economy's long-run aggregate supply (LRAS) curve on the graph.

 

Suppose now the government passes a law that reduces unemployment benefits in a way that causes unemployed workers to seek out new jobs more quickly. This change in policy will cause the natural rate of unemployment to    , which will:

 Shift the long-run aggregate supply curve to the right

 Shift the long-run aggregate supply curve to the left

 Not impact the long-run aggregate supply curve

Complete the following table by determining how each event impacts the position of the long-run aggregate supply (LRAS) curve.

 
Direction of LRAS Curve Shift
A government-sponsored training program increases the skill level of the workforce.
    
The government allows more immigration of working-age adults who find work.
    
This economy's primary source of foreign oil decides to cease exports for political reasons.
    
 

6. Why the aggregate supply curve slopes upward in the short run

In the short run, the quantity of output supplied by firms can deviate from the natural level of output if the actual price level deviates from the expected price level in the economy. A number of theories explain reasons why this might happen.

For example, the sticky-price theory asserts that the output prices of some goods and services adjust slowly to changes in the price level. Suppose firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. Many of the firms sell their goods through catalogs and face high costs of reprinting if they change prices. The actual price level turns out to be 90. Faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. Sales from catalogs will    , and firms that rely on catalogs will respond by    the quantity of output they supply. If enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to    the natural level of output in the short run.

Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:

Quantity of Output SuppliedQuantity of Output Supplied
 =  = 
Natural Level of Output+α×(Price LevelActual−Price LevelExpected)Natural Level of Output+�×Price LevelActual−Price LevelExpected
The Greek letter α� represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$2 billion�=$2 billion. That is, when the actual price level exceeds the expected price level by 1, the quantity of output supplied will exceed the natural level of output by $2 billion.

Suppose the natural level of output is $60 billion of real GDP and that people expect a price level of 100.

On the following graph, use the purple line (diamond symbol) to plot this economy's long-run aggregate supply (LRAS) curve. Then use the orange line segments (square symbol) to plot the economy's short-run aggregate supply (AS) curve at each of the following price levels: 90, 95, 100, 105, and 110.

The short-run quantity of output supplied by firms will exceed the natural level of output when the actual price level    the price level that people expected.

 

In the short run, the quantity of output supplied by firms can deviate from the natural level of output if the actual price level deviates from the expected price level in the economy. A number of theories explain reasons why this might happen.

For example, the sticky-wage theory asserts that output prices adjust more quickly to changes in the price level than wages do, in part because of long-term wage contracts. Suppose a firm signs a contract agreeing to pay its workers $15 per hour for the next year, based on an expected price level of 100. If the actual price level turns out to be 110, the firm's output prices will    , and the wages the firm pays its workers will remain fixed at the contracted level. The firm will respond to the unexpected increase in the price level by    the quantity of output it supplies. If many firms face similarly rigid wage contracts, the unexpected increase in the price level causes the quantity of output supplied to    the natural level of output in the short run.

Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:

Quantity of Output SuppliedQuantity of Output Supplied
 =  = 
Natural Level of Output+α×(Price LevelActual−Price LevelExpected)Natural Level of Output+�×Price LevelActual−Price LevelExpected
The Greek letter α� represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$4 billion�=$4 billion. That is, when the actual price level exceeds the expected price level by 1, the quantity of output supplied will exceed the natural level of output by $4 billion.

Suppose the natural level of output is $40 billion of real GDP and that people expect a price level of 110.

On the following graph, use the purple line (diamond symbol) to plot this economy's long-run aggregate supply (LRAS) curve. Then use the orange line segments (square symbol) to plot the economy's short-run aggregate supply (AS) curve at each of the following price levels: 100, 105, 110, 115, and 120.

 

The short-run quantity of output supplied by firms will fall short of the natural level of output when the actual price level    the price level that people expected.

 

In the short run, the quantity of output supplied by firms can deviate from the natural level of output if the actual price level deviates from the expected price level in the economy. A number of theories explain reasons why this might happen.

For example, the misperceptions theory asserts that changes in the price level can temporarily mislead firms about what is happening to their output prices. Consider a soybean farmer who expects a price level of 100 in the coming year. If the actual price level turns out to be 110, soybean prices will    , and if the farmer mistakenly assumes that the price of soybeans increased relative to other prices of goods and services, she will respond by    the quantity of soybeans supplied. If other producers in this economy mistake changes in the price level for changes in their relative prices, the unexpected increase in the price level causes the quantity of output supplied to    the natural level of output in the short run.

Suppose the economy's short-run aggregate supply (AS) curve is given by the following equation:

Quantity of Output SuppliedQuantity of Output Supplied
 =  = 
Natural Level of Output+α×(Price LevelActual−Price LevelExpected)Natural Level of Output+�×Price LevelActual−Price LevelExpected
The Greek letter α� represents a number that determines how much output responds to unexpected changes in the price level. In this case, assume that α=$2 billion�=$2 billion. That is, when the actual price level exceeds the expected price level by 1, the quantity of output supplied will exceed the natural level of output by $2 billion.

Suppose the natural level of output is $50 billion of real GDP and that people expect a price level of 95.

On the following graph, use the purple line (diamond symbol) to plot this economy's long-run aggregate supply (LRAS) curve. Then use the orange line segments (square symbol) to plot the economy's short-run aggregate supply (AS) curve at each of the following price levels: 85, 90, 95, 100, and 105.

 

The short-run quantity of output supplied by firms will exceed the natural level of output when the actual price level    the price level that people expected.

 

7. Determinants of aggregate supply

The following graph shows an increase in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the right from AS1AS1 to AS2AS2, causing the quantity of output supplied at a price level of 100 to rise from $200 billion to $250 billion.

 

The following table lists several determinants of short-run aggregate supply.

Complete the table by selecting the changes in each scenario necessary to increase short-run aggregate supply.

 
Change Necessary to Increase AS
Regulations on the firm
    
Human capital
    
Input prices
    
 

The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS1AS1 to AS2AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion.

 

The following table lists several determinants of short-run aggregate supply.

Complete the table by selecting the changes in each scenario necessary to decrease short-run aggregate supply.

 
Change Necessary to Decrease AS
Technology
    
Tax rates
    
Inflation expectations
    
 

The following graph shows a decrease in short-run aggregate supply (AS) in a hypothetical economy where the currency is the dollar. Specifically, the short-run aggregate supply curve shifts to the left from AS1AS1 to AS2AS2, causing the quantity of output supplied at a price level of 100 to fall from $200 billion to $150 billion.

 

The following table lists several determinants of short-run aggregate supply.

Complete the table by selecting the changes in each scenario necessary to decrease short-run aggregate supply.

 
Change Necessary to Decrease AS
Regulations on the firm
    
Human capital
    
Input prices
    
 

8. Economic fluctuations I

The following graph shows a hypothetical economy in long-run equilibrium at an expected price level of 120 and a natural output level of $600 billion. Suppose the economies of several foreign countries experience rapidly growing incomes, causing foreign spending on domestic goods and services to increase.

Using the graph, shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the economic prosperity abroad.

 

In the short run, the increase in foreign spending on domestic goods associated with expansion abroad causes the price level to    the price level people expected and the quantity of output to    the natural level of output. The economic prosperity abroad will cause the unemployment rate to    the natural rate of unemployment in the short run.

Again, the following graph shows a hypothetical economy experiencing long-run equilibrium at the expected price level of 120 and natural output level of $600 billion, prior to the increase in foreign spending on domestic goods associated with expansion abroad.

Along the transition from the short run to the long run, price-level expectations will    and the    curve will shift to the    .

Using the graph, illustrate the long-run impact of the economic prosperity abroad by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve in the appropriate directions.

In the long run, due to the economic prosperity abroad, the price level    , the quantity of output    the natural level of output, and the unemployment rate    the natural rate.

 

The following graph shows a hypothetical economy in long-run equilibrium at an expected price level of 120 and a natural output level of $300 billion. Suppose a sudden and severe contraction in the housing market reduces the value of homes and causes consumers to spend less.

Using the graph, shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the housing market slump.

In the short run, the decrease in consumption spending associated with the housing market contraction causes the price level to    the price level people expected and the quantity of output to    the natural level of output. The housing market slump will cause the unemployment rate to    the natural rate of unemployment in the short run.

Again, the following graph shows a hypothetical economy experiencing long-run equilibrium at the expected price level of 120 and natural output level of $300 billion, prior to the decrease in consumption spending associated with the housing market contraction.

Along the transition from the short run to the long run, price-level expectations will    and the    curve will shift to the    .

Using the graph, illustrate the long-run impact of the housing market slump by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve in the appropriate directions.

In the long run, due to the housing market slump, the price level    , the quantity of output    the natural level of output, and the unemployment rate    the natural rate.

 

The following graph shows a hypothetical economy in long-run equilibrium at an expected price level of 120 and a natural output level of $600 billion. Suppose the government increases spending on building and repairing highways, bridges, and ports.

Using the graph, shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the increase in government spending.

In the short run, the increase in government spending on infrastructure causes the price level to    the price level people expected and the quantity of output to    the natural level of output. The increase in government spending will cause the unemployment rate to    the natural rate of unemployment in the short run.

Again, the following graph shows a hypothetical economy experiencing long-run equilibrium at the expected price level of 120 and natural output level of $600 billion, prior to the increase in government spending on infrastructure.

Along the transition from the short run to the long run, price-level expectations will    and the    curve will shift to the    .

Using the graph, illustrate the long-run impact of the increase in government spending by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve in the appropriate directions.

In the long run, due to the increase in government spending, the price level    , the quantity of output    the natural level of output, and the unemployment rate    the natural rate.

 

9. Economic fluctuations II

The following graph shows the aggregate demand curve (ADAD), the short-run aggregate supply curve (ASAS), and the long-run aggregate supply curve (LRASLRAS) for a hypothetical economy. Initially, the expected price level equals the actual price level, and the economy experiences long-run equilibrium at a natural level of output of $110 billion.

Suppose a bout of severe weather drives up agricultural costs, increases the costs of transporting goods and services, and increases the costs of producing goods and services.

Use the graph to help you answer the questions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.)

Hint: For simplicity, ignore any possible impact of the severe weather on the natural level of output.

 

The short-run economic outcome resulting from the increase in production costs is known as    .

Suppose now that the government decides not to take any action in response to the short-run impact of the severe weather.

In the long run, given that the government does nothing, the output level in the economy will equal

 

billion and the price level will equal

 

.

The following graph shows the aggregate demand curve (ADAD), the short-run aggregate supply curve (ASAS), and the long-run aggregate supply curve (LRASLRAS) for a hypothetical economy. Initially, the expected price level equals the actual price level, and the economy experiences long-run equilibrium at a natural level of output of $90 billion.

Suppose war in the world's main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services.

Use the graph to help you answer the questions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.)

Hint: For simplicity, ignore any possible impact of the higher oil prices on the natural level of output.

 

The following graph shows the aggregate demand curve (ADAD), the short-run aggregate supply curve (ASAS), and the long-run aggregate supply curve (LRASLRAS) for a hypothetical economy. Initially, the expected price level equals the actual price level, and the economy experiences long-run equilibrium at a natural level of output of $80 billion.

Suppose war in the world's main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services.

Use the graph to help you answer the questions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.)

Hint: For simplicity, ignore any possible impact of the higher oil prices on the natural level of output.

 

The short-run economic outcome resulting from the increase in production costs is known as    .

Suppose now that the government immediately pursues an accommodative policy by increasing government purchases in response to the short-run impact of the higher oil prices.

In the long run, given that the government pursues accommodative policy, the output level in the economy will equal

 

billion and the price level will equal

 

.